By David Braze (TMF Pixy)

ALEXANDRIA, VA (Jan. 24, 2000) -- No, while it's important, the title of this article doesn't refer to your investments. Instead, it refers to something I consider an often neglected yet important part of retirement planning: Who will get what's left in your traditional IRA after you're gone? Yes, that's right, I'm referring to the named beneficiary of your IRA. The person or persons you name to receive the balance of your traditional IRA after you die affects both the family's total tax burden and how you will take distributions from your tax-deferred retirement accounts. Given the enormous size of many of today's IRAs due to large retirement plan distribution rollovers and the fantastic market growth over the last few years, that impact could be quite large indeed.

Some of these issues are covered in my article Designating IRA Beneficiaries -- It Does Matter. Additionally, our Foolish tax maven, TMF Taxes (Roy Lewis), also penned a superb article touching on this topic entitled The New S-t-r-e-t-c-h IRA. If you haven't read those pieces, I encourage you to do so. Both contain some exceedingly valuable nuggets that could help prevent a major asset from becoming a major liability to your family.

For this article, I'm really concerned about the attention we gave to the documents we completed and signed when we opened the IRA. As an example, virtually all of us married types would have named a spouse as beneficiary of the account. But did we name any contingent beneficiaries in case the spouse predeceases us? If not and if indeed that situation arises, then two things will happen. First, when we reach the age for minimum required distributions (MRD) we must use a single life expectancy method of withdrawal instead of a potentially longer joint life expectancy method. The latter helps to minimize income taxes. Second, after we have begun MRD, then when we die the lack of a living beneficiary means the balance in our account must be paid to our estate and taxed in a year. If we haven't reached MRD age yet, it must be paid out and taxed no later than five years after death. In either case, estate and income taxes could eliminate a large portion that would otherwise go to surviving heirs.

Most of us want to keep as much of our hard-earned cash out of Uncle Sam's and Auntie State's grasping hands as long as we can. With IRAs, though, there comes a point when we must take the money. Deciding how to take MRD at age 70 1/2 will affect how much we surrender to both governments and how long we can avoid doing so. We can take the money based on a single life expectancy (ours) or a joint life expectancy (ours and a beneficiary). The latter stretches the payments out over a longer period during our life, thus keeping taxes down. And, depending on whether we use a recalculation method or a term certain method in determining the life expectancy factor to be used, we can spread those payments out over an even longer period after we die.

I know, I know. This stuff is complicated. So for more details, see the explanation provided in 70 1/2: Ya Gotta Take It Sometime. It might help to clear up the issues for you. Regardless of what we might be able to do legally, though, we must know in advance what our IRA provider will let us do.

Our IRA adoption agreement tells us what's allowed, so we must read it to find out. Surprisingly, providers can be very strict as to what they will permit despite what the law allows. Some institutions may dictate the mandatory use of the recalculation method for MRD. Others may stipulate only the term certain approach may be used. Most providers today permit both, but be forewarned that all do not. Also, bear in mind that the MRD method used must be elected by you prior to the time the MRD must begin. Otherwise, the IRA adoption agreement will contain a default method, and that method may not conform to your desires.

The adoption agreement will also specify how the account balance will be paid to nonspousal beneficiaries. That may also come as a shock because the agreement may require full distribution within five years instead of over a longer period as allowed by law. Other things to look for include the right to name a contingent beneficiary in the event of the original beneficiary's death and how the IRA will treat multiple beneficiaries. Still, unless we read that boring document, we really don't know what our IRA permits. To me, it seems prudent to have that knowledge before I begin MRD and before I leave this world for another. That way I can better ensure things will happen the way I want them to.

Lastly, you should confirm that the IRA provider has a valid beneficiary designation on file for you. A recent Wall Street Journal article highlighted the case in which one was lost by the provider. The nasty result? An inheriting daughter saw the money go to the estate where it was immediately taxed. If she inherited that $95K IRA as desired by her deceased parent, she not only could have avoided that immediate taxation problem, but (invested at 10% annually) she would have seen the IRA grow over her lifetime to provide her with $1.5 million after taxes. Talk about a waste!

What, then, are the lessons for today? First, ensure that your IRA will allow both the beneficiary designation(s) and the MRD method you want. If not, switch to a provider that will. Next, review your IRA beneficiary designation(s), know how your provider will calculate your MRD, and make sure the IRA allows the greatest flexibility for distribution to beneficiaries on your death. To guarantee all that happens, I suggest you request a blank beneficiary form from your provider; complete it on arrival; double-check it for accuracy; make a copy of the signed form for your records; and then return it via certified mail with a return receipt requested. Finally, let your family know where to find those records and what their options will be upon your demise. All these steps may not prevent a tax problem from arising, but they certainly will help in keeping such problems to a minimum.

As always, post your comments and questions on the Retired Fools board.

Best to all... Pixy